Life Insurance Consumer Advocacy Center

1. The Short Version:

The mission of the Life Insurance Consumer Advocacy Center (the “Center”) is

• to alert the public, including consumers and policymakers, about the potential risks of certain types of life insurance policies, particularly life insurance investment schemes (“LIIS”) falling within the category of universal life, and about unfair practices in how such policies are sold; and
• to advocate for reasonable and essential consumer protections for these types of products.

 

1. The Longer Version:

The Center was founded in 2020 based on a conviction that consumers of cash value life insurance are poorly served by insurance markets in California and throughout the United States.  By “cash value life insurance,” we mean life insurance that not only provides death protection like a term life insurance policy would, but also has an investment component (which we’ll call a “savings account”) associated with it.  A consumer can pay more into the policy’s savings account than the cost of obtaining death protection and can thereby build up a “cash value” in the savings account that can be withdrawn or borrowed against.  Cash value life insurance includes indexed universal life, "traditional"  universal life, variable universal life, and whole life.  Whole life policies typically provide consumers with greater certainty about costs than universal life policies because a whole life policy has a guaranteed annual premium for the life of the policy.  This greater certainty helps to avoid some of the most serious problems with the kinds of LIIS we discuss below.

Life insurance can be a good thing, and in our view society as a whole should buy more life insurance than it currently does.  But the key function of life insurance – the reason life insurance was invented by the ancient Romans – is to provide money to help family or other loved ones at the event of the insured person’s death.  This benefit is called “death protection,” and it is readily available from many companies in the insurance marketplace.  Term life insurance, which provides death protection for a pre-determined period of time but has no cash value, is a product that is not difficult to understand and is not subject to many of the abusive sales practices that afflict the LIIS market.

LIIS is a very different story.  The original purpose of developing policies with cash value (initially whole life) was to offer a policy that would provide death protection not just for a fixed term of, say, 20 years, but for life, or as long as the consumer wants to keep the policy, with a premium that was higher than term but guaranteed never to increase.  With the introduction in the late 1970s of universal life policies, the market moved away from guaranteed lifetime premiums to a more flexible and superficially more attractive “pay what you want – when you want” approach to premium funding.  The problem was that consumers had little or no way to know how much money it would cost to keep the policies in force for a lifetime, and a great many such policies have terminated either because fees charged by the insurer consumed the policy value, or because the policyholder voluntarily surrendered the policy.

Further moving away from the original concept of guaranteed premiums no matter how long you live has been the evolution of investment-oriented universal life policies designed to downplay the death protection component and emphasize the savings account aspect of the policy, which can have tax advantages over normal savings accounts.   This aspect of life insurance is often marketed as a “private pension” or “private retirement account,” into which the policyholder deposits substantial premium dollars in the hope of generating significant interest earnings and cash value – typically by age 65.

In theory, the money in the savings account grows (from interest credited to the savings account by the insurance company) until the policyholder is ready to retire, and then the policyholder can access that money, tax-free, for retirement income or for other purposes, via withdrawals and loans from policy cash values.  Further, in theory, any loans the policyholder took from the policy’s cash value would be paid off by the death benefit when the insured dies, and no one would ever pay any taxes on the money that accumulated in the savings account (from interest credited to the savings account by the insurance company) over the years.  It sounds great, but for the vast majority of consumers who purchase LIIS, the policy they buy will fail to achieve these theoretical benefits and the consumers' objectives.

This is true because very few of the policies will remain in force (“persist”) until the death of the insured.  If the policy terminates before the insured dies, the policy will not pay a death benefit and the policy cannot qualify for any tax benefits.  Indeed, there may be serious tax consequences for the policyholder if the policy terminates with outstanding loans in excess of the policyholder’s tax basis, as we explain in the Lapse Problem section.

Policies terminate or “lapse” for a variety of reasons.  Most often policies lapse because the premiums paid are insufficient to offset the fees (including cost of insurance charges and a variety of other fees) deducted by the insurance company from the policy’s savings account; these fees gradually consume all the money in the savings account, and then the policy lapses.  While the consumer could keep the policy in force by paying more premiums, consumers often abandon the policy, and their investment in it, rather than continue to pay premiums.  Policies also lapse because consumers cut their losses by voluntarily surrendering the policy to recover at least a portion of their investment.  If a policy lapses, the consumer will have received death protection while the policy was in force, but the primary purpose of LIIS is not to provide death protection but to generate tax-free earnings, which a lapsed policy cannot do.  Indeed, many buyers of LIIS do not need or want death protection; they buy the policy primarily because they are looking for a tax-free investment that can hep fund their retirement and are led to believe that LIIS can deliver that benefit.

Policy lapse by abandonment or surrender is the fate of the vast majority of LIIS policies, as evidenced by cumulative lapse rates for LIIS policies in the range of 80% to 90% or higher.  See Lapse Problem section.  These lapsed policies should be considered failed policies.  Even failure rates as “low” as 50% would raise serious questions about how well consumers were being served by the insurance markets under existing laws and regulations.  Society rarely tolerates failure rates of 50% for expensive products, let alone the much higher failure rates common among universal life policies.

There is a social inequality issue present as well because the LIIS policies most likely to fail are those sold to lower- or middle-income consumers as opposed to those who are well off.  Rich people can put more money into their policies, thus earning higher interest credits relative to policy fees than less wealthy individuals, who typically cannot or do not invest enough money in their policies for interest credits to offset policy fees.  When fees consume the policy value, the policy lapses.   The fees collected by the insurer from the lapsed policies help support its bottom line and allow it to charge relatively lower fees or to provide persistency bonuses to those polices that remain in force for a prescribed period – generally after 10 years.  Thus, lapsed policies subsidize the policies that persist, and wealthier individuals reap the benefits.

Much needs to be done, beginning with understanding the problem discussed above, which we call the Lapse Problem.  Life insurance consumers and policymakers need to understand it.  They also need to understand other aspects of the way LIIS policies are designed or sold that harm consumers, for example by making the policies appear to be far more attractive and less costly than they are in reality.  Accordingly, the Center’s mission is

• to alert the public, including consumers and policymakers, about the risks of certain types of life insurance policies, particularly life insurance investment schemes (LIIS” that fall within the category of universal life, and about unfair practices in how such policies are sold; and
• to advocate for reasonable and essential consumer protections for these types of products.